islamic (non-interest) banking and finance -oyindamola …
TRANSCRIPT
VALID (SAHIH)
IRREGULAR (FASID)
VOID (BATIL)CO
NT
RA
CT
3
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Classification of Contracts According to their
Legal Validity:
1. Valid Contract: A contract which its nature/essence and attributes are in line with
Islamic Law. A valid contract enjoys the following features:I. Its elements are complete II. Conditions relating to elements are met, andIII. It is free from external prohibited elements
2. Irregular Contract: In this contract, elements are present, and all the essential
conditions are complete, however, an external attribute included in this contract is forbidden by the lawgiver.
The contract is legal in respect to its origin, but it is irregular due to the prohibition of the attribute.
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
3. Void Contract:
A void contract is against Islamic Law in respect to both its essence and external attributes. It does not give any effect.
No ownership is transferred nor is any type of obligation created.
There is no room for ratification.
•Contracting Parties: Buyer and Seller
• Discernment – excludes the insane, the intoxicated, and the minor without intellect;
• Legal capacity – excludes the imbecile and a person placed under guardianship;
• Ownership or representation of owner or authority over an owner or his deputy;
• Assent (negated by compulsion, ignorance, error, deception, concealment of defect, jest): “O you who believe! Do not devour the wealth of one another unjustly, except if it is from a trading based on consent from yourselves” [Qur’an 4 : 29].
•Subject Matter: Al Thaman (Consideration) and Al Muthman (Object of sale)
• Existence – Give exception to Salam and Istisna’
• Permissibility – of possession and having a utility permissible for exchange (excluded are impure items, like alcohol and pork, items with no utility like insects or those with impermissible utility like musical instruments or with utility that is impermissible for exchange like dogs)
• Known to the contracting parties
• Ability and certainty of delivery
•Offer and Acceptance:
• Clear statements denoting mutual consent by custom;
• Continuity (negated by revocation, rejection, lapse of time or separation)
• Communication
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Element of a Sale Contract:
1) Transfer of the Subject Matters of the Contract• It is binding on the buyer to effect the transfer of the price, and
in the event of dispute, he is the party to be compelled to effect the transfer first.
• The seller is entitled to keep hold of the sold item till he receives the price.
• Expenses of delivery of price is on the buyer and of the sold item is on the seller, except if there is a custom or stipulation to the contrary.
• It is not permissible to sell an identified item on a delayed delivery basis.
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Effects of the Sale Contract:
2) Taking of Possession: It is the appropriation of an item and having the right of administration and disposal over it and the removal of all restrictions over it, real or customary;
• The basis for determining mode of taking of possession is al ‘urf (custom)
• There is actual possession by relinquishing of immovables, and physical and corporeal delivery in movables; and constructive possession depending on the item and the contract. Valid registration and possession of documents like bills of lading and warehouse receipts
• Constructive possession includes:
I. Crediting money to an account directly or through bank transfer;
II. Depositing money to an account upon the demand of the one taking possession or with his consent;
III. Receipt of a bank cheque or bank draft;
IV. Payments of a credit card and receipt of a voucher by a merchant signed by the credit card holder.
• Prior possession of a tangible item stands in place of subsequent possession irrespective of the earlier possession being of liability or of trust.
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Effects of the Sale Contract:
3) Transfer of Responsibility and Liability over the sold item• Bearing the responsibility over loss, deficiency or damage in a contract that is
subject of sale or lease.
• After taking of possession, responsibility is on the buyer except in the case of sale of crops that become affected by crop damage or crop failure;
• Responsibility is transferred to the buyer with the conclusion of the sale contract, even before taking of possession, except in five cases:
1. Sale of an item that is not there based on description;
2. Sale of an item in a sale contract that has an option condition;
3. Sale of fruits before complete ripeness;
4. Sale of an item that is sold based on volume, weight or number
5. Sale of an item in an invalid sale contract
In all the 5 cases, responsibility is on the seller until the buyer takes possession.
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Effects of the Sale Contract:
4) Disposal of the Sold Item by Sale Before Taking of Possession
• It is not permissible if the sold item is foodstuff that is sold by measure only.
5) Disposal of the Sold Item by Other than Sale Before Taking of Possession
• It is permissible to dispose a sold item before taking possession even if it is foodstuff that is sold by measure, if the disposal in not through an exchange contract, which includes: gift, charity, loan, partnership or sale at cost price.
ESSENTIAL ELEMENTS OF ISLAMIC FINANCE
Effects of the Sale Contract:
TRADE BASED CONTRACTS
• MURABAHA
• BAI’-MUAJJAL
• SALAM
• ISTISNA’
LEASE BASED CONTRACTS
IJARAH
IJARAH OF SERVICES
EQUITY (PARTNERSHIP) BASEDCONTRACTS
MUSHARAKAH
MUDARABAH
FEE BASED CONTRACTS
WAKALAH
KAFALAH
OTHER CONTRACTS
QARD HASSAN (BENEVOLENT LOAN)
13
ISLAMIC FINANCE CONTRACTS
MURABAHA (COST PLUS FINANCING)
THE ORIGIN OF MURABAHA IS THE WORD
‘RABAHA’ (I.E. TO MAKE A PROFIT (FROM A DEAL).
IT IS ONE OF THE TRUST SALES CONTRACTS,
WHICH REQUIRES A SELLER TO FULLY DISCLOSE
THE COST PRICE OF A GOOD OR ASSET AND HIS
PROFIT MARGIN, WHICH COULD BE A LUMP SUM
OR A PERCENTAGE OF THE COST PRICE.
A MURABAHA IS A SALE IN WHICH THE SELLER’S
COST OF ACQUIRING THE ASSET AND THE PROfiT
EARNED FROM IT ARE DISCLOSED TO THE
CLIENT OR BUYER.
THE MURABAHA OPERATED BY NIFIS IS
REFERRED TO AS MURABAHA TO PURCHASE
ISLAMIC FINANCE CONTRACTS
MURABAHA …..CONT’D
August 23, 2021 ©2019 Your Company. All Rights Reserved
15
FEATURES OF MURABAHA
ISLAMIC FINANCE CONTRACTS
SUBJECT MATTER
The subject
matter/asset must
exist at the time of
contract execution.
The bank must own
the asset and have
either physical or
constructive
possession. The
asset must be a
tangible good, clearly
identified, quantified
and Shariah
compliant
The Murabaha asset cost,
including all expenses
involved in the asset’s
acquisition, must be
declared to the client
Parties to the contract
establish a profit rate by
mutual consent or in
relation to a specific and
known benchmark which
must be disclosed.
The Murabaha price may be
charged at spot or be
deferred and paid as a
lump sum at the end of the
contract or in installments
on fixed dates during the
term.
PRICE DEFAULT REPRICING
There is no concept of a
late payment in a
Murabaha contract,
however, a charity clause
is established at contract
execution to serve as a
deterrent to default.
Based on the charity
clause, the client is
obliged to pay a
predetermined amount to
a designated charity
account, which shall not
be benefited from by the
Bank, its staff or ACE
members, and which
disbursement is to be
supervised by the ACE.
This is prohibited
because the Shariah
does not permit an
increase in debt once it
is fixed.
Rescheduling is only
permissible when the
creditor provides an
extension to ease the
burden of a debtor, so
a roll-over where the
bank increases the
debt in return for an
extension is
impermissible as the
resulting amount of
debt is analogous to
riba or interest.
MURABAHA……CONT’D
STEPS OF MURABAHA EXECUTION
August 23, 2021 ©2019 Your Company. All Rights Reserved
16
ISLAMIC FINANCE CONTRACTS
PRU (Purchase Requisition Undertaking)
The client’s
submission of
a purchase
requisition for
Murabaha
goods.
EARNEST MONEY
The client’s unilateral
promise to purchase the
Murabaha goods and the
financial institution’s
acceptance of collateral.
The Bank requests the
client to furnish a security
or earnest money called
Haamish Jiddiyyah. In
case the client backs out
from entering into a
Murabaha, the bank
makes up for the actual
loss from it and returns the
remainder to the client.
AGENCY
The agency agreement
between the financial institution
and the client or a third party.
During the Agency stage the
bank’s exposure to asset risk.
The Bank must also ensure
that the asset to be purchased
is not already in the client’s
possession by paying to the
supplier before the
agent/customer purchases the
goods. The Bank can equally
procure Murabaha goods
directly or establish a third
party agency.
POSSESSION
The
possession of
the Murabaha
goods by the
agent on
behalf of the
financial
institution
ACTUAL SALE
The exchange
of an offer and
acceptance
between the
client and the
financial
institution to
implement the
Murabaha sale.
BAI’ MUAJJAL (DEFERRED/CREDIT SALE)
ISLAMIC FINANCE CONTRACTS
Bai’ Muajjal is a contract between a
Buyer and a Seller for the sale of a
specific asset to the Buyer at an
agreed fixed price payable at a fixed
future date in lump sum or by fixed
instalments.
As a Sale contract, the buyer must
have ownership of the asset before
the sale of same. The ownership may
be actual or constructive
DIFFERENCES BETWEEN MURABAHA AND BAI’-MUAJJAL
ISLAMIC FINANCE CONTRACTS
MURABAHAH BAI’ MUAJJAL
1. Sale on an agreed mark-up which
may be at the spot or deferred
Sale on credit or deferred payment basis
2. Key objective of a Murabahah is to
make profit, the profit mark-up is thus
an essential part of the contract
The key objective of a Bai’ Muajjal is
deferred payment of a sale which may be
at discount, par, or premium of the cost
price of the asset.
3. As one of the Trust Sale contracts,
the actual purchase price of the asset
and the mark-up must be
transparently disclosed in the contract
document
The Vendor/Seller is not bound to disclose
the actual purchase price to the customer
orally or in the contract documents.
4. Murabahah purchase may be effected
either in cash or on credit
Bai’ Muajjal sale must always be on credit.
Payment is deferred.
ISLAMIC FINANCE CONTRACTS
i. Ribawi items (are six items associated to interest) against same
except while fulfilling the required rules of same quantity and on
the spot and if different any quantity but also on the spot as
guided by the Prophet (peace be upon him).
ii. Non-existent items except in Salam and Istisna.
iii. Items not owned by the seller.
iv. Items already owned by the buyer (buy back).
v. Items that could not be delivered by the seller.
vi. Injurious assets that are harmful to either individual or society.
vii. Items prohibited by Shari’ah such as alcohol, pork meat and pork
accessories, dead animals, blood, phonographic films, etc.
viii. Stolen items if the seller is aware.
ITEMS THAT CANNOT BE FINANCED IN SALE CONTRACTS
ISLAMIC FINANCE CONTRACTS
Ribawi items or similar against one another.
Gold-Silver
Gold –Naira ALL MUST BE ON THE SPOT
Naira – USD
USD – Gold
Transactions where both subject and payment are
deferred.
ITEMS THAT CANNOT BE SOLD ON DEFERRED PAYMENT
ISLAMIC FINANCE CONTRACTS
Vehicles
Household appliances
Undeveloped plot of land
Automobiles
Computers and accessories
Electronics
Furniture
Agricultural equipment
Imports Finance
Any other goods that can be easily delivered
AREAS OF FINANCING USING MURABAHA/BAI’ MUAJJAL
ISLAMIC FINANCE CONTRACTS
i. Identification of Asset.
ii. Promise to Purchase.
iii. Provision of a valid invoice in the name of the bank or endorse to
the bank.
iv. Agency Agreement.
v. Offer Letter (containing details including price and profit mark-up
for Murabaha only). While in Bai Muajjal, Bank is only required to
disclose the sale price).
vi. Necessary Documentations.
vii. Purchase of asset by the Bank by way of disbursement directly to
the supplier/vendor.
viii. Signing of Murabaha/Bai Muajjal agreement and other sale
related documents.
PROCESS FLOW OF MURABAHA/BAI’ MUAJJAL
SALAM (FORWARD SALE)
ISLAMIC FINANCE CONTRACTS
Salam is one of the exceptions to
the general rule of sale, i.e.
tangibility, availability and
ownership of the asset to be sold.
Salam is a sale where the price
of the subject matter is paid in full
at the time of the contract’s
execution while the delivery of
the subject matter is deferred to a
future date.
SALAM (FORWARD SALE)…..CONT’D
ISLAMIC FINANCE CONTRACTS
It is not necessary that the subject
matter exist, and be owned and
possessed by the seller at the time of
the Salam’s execution as is the
customary requirement of a standard
sale, provided it meets the other criteria
specific to it.
Salam allows the buyer to purchase
commodities for a price lower than the
spot market price, while providing
capital for the vendor at the point when
he needs it most, thus creating a win-
win situation. The vendor wins and the
purchaser wins.
FEATURES OF SALAM (FORWARD SALE)
ISLAMIC FINANCE CONTRACTS
HOMOGENEITY
Salam may be
executed for
homogeneous
commodities but
not for specific
commodities and
mediums of
exchange
The quantity and quality
of Salam goods must be
specified in order to
avoid any ambiguity that
may lead to dispute
between contracting
parties
NO AMBIGUITY PRICE DELIVERY
Salam price must be
paid at spot. The price
is fixed and cannot be
increased due to an
increase in the price of
Salam goods in the
market during the
contract’s term
The place of
delivery of Salam
goods must be
specified and they
must be delivered in
their entirety on a
fixed future date or
in instalments on
predetermined
dates
FEATURES OF SALAM (FORWARD SALE)….CONT’D
ISLAMIC FINANCE CONTRACTS
PARALLEL SALAM
Salam goods cannot be sold to a
third party before receiving
possession however a parallel Salam
may be executed for them. A Parallel
Salam is a transaction executed
simultaneously with the original
Salam. The buyer of goods in the
first Salam is the seller of goods in
the second or Parallel Salam. It is
permitted with a third party only.
The Khiyar al ‘Aib
(option of defect) may
be exercised for
Salam subject matter,
however, not the
Khiyar al Rooyat
(option of refusal).
OPTIONS SALAM TERMINATION
Once executed, a Salam may
not be revoked unilaterally by
either party. It is a sale
contract binding on both
parties and may be
terminated completely or
partially by mutual consent
by returning the actual or
proportionate amount of the
price paid
ISLAMIC FINANCE CONTRACTS
AREAS OF FINANCING USING SALAM
Agricultural Financing such as fertilizer, seeds,
equipment, etc.
Working Capital Financing (for raw materials
requirement of companies).
Discussion/Request to the Bank
Application
Promise to sell
Items identified and description made
Bank enters into parallel Salam with a buyer
Offer Letter (with full details)
Necessary documentation
Sale/Buy agreement signed
Disbursement is made to customer
Described goods supplied to the Bank at harvest or on maturity
Facility terminated.
Bank deliver goods to the second buyer in parallel Salam.
ISLAMIC FINANCE CONTRACTS
PROCESS FLOW OF SALAM……CONT’D
ISTISNA’ (MANUFACTURING/CONSTRUCTION) FINANCING
ISLAMIC FINANCE CONTRACTS
Istisna, like Salam, is the second exception
to the general rule of sale.
An Istisna is a transaction used to acquire an
asset manufactured on order. It may be
executed directly with the supplier or any
other party that undertakes to have the asset
manufactured.
There are usually three parties involved in an
Istisna contract; the Istisna requestor, or
orderer, the manufacturer and the Bank.
An Istisna takes place when one party
agrees to manufacture a product for another
party at a specific price. This agreement
involves an exchange of an offer and an
acceptance which completes the contract.
FEATURES OF ISTISNA’
ISLAMIC FINANCE CONTRACTS
SUBJECT MATTER
The subject matter
of an Istisna need
not exist, be
owned or
possessed by the
manufacturer at
the time of
contract execution
It must be an item that
is manufactured as
customary market
practice and undergoes
processing to convert
from one form to
another
SUBJECT MATTER SUBJECT MATTER PRICE
The quantity or
quality of Istisna
subject matter can
be changed by
mutual consent of
the contracting
parties
The Istisna price, agreed
at the time of contracting
between the istisna
requestor and the
manufacturer, may be
paid at the time of
contract execution, in
fixed instalments over the
contract’s term or as a
lump sum at the end of
the contract’s term
FEATURES OF ISTISNA’
ISLAMIC FINANCE CONTRACTS
PARALLEL ISTISNA
A parallel Istisna is a
second Istisna
contract executed
alongside the first
Istisna. The
manufacturer in the
original contract
serves as the Istisna
requestor in the
parallel contract and
profits from a
difference in price.
The parallel Istisna is
completely separate
and independent of
the original Istisna
contract
The Islamic bank
may demand security
in its capacity as
requestor or
manufacturer. Such a
security is called
Urbun. Urbun is a
non-refundable down
payment that the
seller/manufacturer
receives from the
buyer/requestor, in
order to secure the
purchase of goods
URBUN NO BUY-BACK ISTISNA TERMINATION
The Istisna must
not involve a buy-
back at any stage.
Before the Istisna
is executed it is
important to
ensure that the
contracting parties
are separate and
independent legal
entities
Either of the two
contracting parties may
terminate the Istisna
unilaterally provided the
manufacturing process
has not commenced. If
manufacturing has
begun, then the contract
is binding on both parties
and can only be
terminated by mutual
consent
ISLAMIC FINANCE CONTRACTS
House Financing
Project Financing such as power, roads, water
treatment plants etc.
Manufacturing Companies
Financing of Raw Materials
Government Awarded Contracts
Any other Shariah compliant project.
AREAS OF FINANCING USING ISTISNA’
ISLAMIC FINANCE CONTRACTS
Idea discussion/request
Promise to buy
Identification and description of asset to be manufactured.
Identification and engagement of contractor for second Istisna
Offer letter (including details of price, payment date and delivery)
Necessary documentation
Istisna Sale Agreement
Agreement with contractor (separate and independent from the Sale
agreement above)
Completion of the project
Delivery to the Bank and the Bank to the customer.
PROCESS FLOW OF ISTISNA’…….CONT’D
DIFFERENCES BETWEEN SALAM AND ISTISNA’
ISLAMIC FINANCE CONTRACTS
Salam Istisna
Subject Commodity Agricultural produce or existing
and off the shelf goods or assets
Items not in existence or not fully
developed or assembled to be fit
for purpose
Price Paid in full in advance Flexible; may be in advance, at
milestones or upon project delivery
Time of Delivery Must be fixed at the contracting
stage
May be reviewed, especially in the
case of project delivery
Cancellation of Contract Can not be unilaterally cancelled
once concluded
Can be cancelled unilaterally even
after concluding the contract, but
must be before manufacturer or
developer commence the project
IJARAH (LEASING)
IJARAH IS THE LEASE OF A
SPECIfiC ASSET OR SERVICE TO A
CLIENT FOR AN AGREED PERIOD
OF TIME IN EXCHANGE FOR RENT
WHICH AT THE END OF THE LEASE
PERIOD MAY RESULT IN
TRANSFERRING THE SUBJECT
MATTER’S OWNERSHIP TO THE
LESSEE. IN PRINCIPLE, AN IJARAH
CONTRACT IS EXECUTED FOR AN
ASSET OWNED BY THE LESSOR OR
AN USUFRUCT OWNED BY THE
SUB-LESSOR.
THE SUBJECT OF LEASE MUST
HAVE A VALUABLE USE, SO THINGS
HAVING NO USUFRUCT AT ALL
CANNOT BE LEASED.
ISLAMIC FINANCE CONTRACTS
IJARAH (LEASING)…..CONT’D
August 23, 2021
©2019 Your Company. All Rights Reserved
38
TYPES OF
IJARAH
A lease contract in which someone
hire/employ a person on wages. It is
a contract in which someone is hired
to provide his skills and services and
gets paid in return for his services
and expertise
IJARAH TUL
AAMAAL
IJARAH TUL
MANAFAAY
A lease contract executed to transfer the
benefits of an asset, service or usufruct in
exchange for an agreed price. It does not
involve the services of specific persons.
ISLAMIC FINANCE CONTRACTS
IJARAH (LEASING)……CONT’D
Ijarah classification based on transfer of ownership to lessee
Standard/Operating Ijarah
A lease contract where the lesseebenefits from the asset or a servicefor a specific time period but it doesnot result in the eventual transfer ofownership of the asset to the lessee.
Ijarah wa Iqtina
A lease contract to transferownership of the leased asset tothe lessee gradually through thelease period.
Ijarah Muntahiah Bitamleek
A lease contract conductedsolely to transfer ownership ofthe leased asset to the lessee atthe end of the lease period.
Ijarah Maushufa fi Dzhimah(Forward Ijarah)
A lease contract used to finance assetunder construction. The customer paysadvanced rent during the constructionperiod of the asset.
ISLAMIC FINANCE CONTRACTS
IJARAH (LEASING)….CONT’D
The client and lessor enter intoa promise to execute an Ijarahfor the usufruct of a particularasset or service
The bank undertakes to providethe asset or service and theclient undertakes to enter into alease contract for it
The asset or service must be ownedby the lessor and made availableto the lessee before the Ijarahcommences
The lease period commencesonce the subject matter of thelease is made available to thelessee.
Prerequisites of an Ijarah
ISLAMIC FINANCE CONTRACTS
ISLAMIC FINANCE CONTRACTS
Idea discussion/Declaration of interest
Promise to rent and buy
Identification of asset
Offer Letter and Acceptance
Ijarah Wa Iqtina Agreement
Necessary documentations
Provision of equity contribution by customer
Purchase of asset by the bank
Signing of agreement (Lease and Sale).
PROCESS FLOW OF IJARAH……..CONT’D
IJARAH SERVICES
IJARAH SERVICES IS BASED
ON THE CONTRACT OF IJARAH
I.E. THE HIRE/ACQUISITION OF
SERVICES OF PERSONS IN
EXCHANGE FOR A FEE,
FINANCIAL OR MATERIAL
CONSIDERATION.
THE BANK ASSIGNS TO THE
CUSTOMER THE ENJOYMENT
OF THE ACQUIRED SERVICE AT
A MARKED-UP RATE, WHICH
THE CUSTOMER PAYS UP IN A
DEFERRED LUMP SUM OR ON
AGREED INSTALMENTS.
ISLAMIC FINANCE CONTRACTS
The service in anIjarah of servicescontract shall berecognized byShariah, valuable,identifiable andaccessible.
The service shall becapable of beingdelivered by theservice provider andassignable by theBank.
Permissible services
in this Ijarah contract
will be: Intangible
assets, such as
trademark, patent,
educational services,
property rent, medical
service, and other
forms of services
which are capable of
being hired or
acquired.
The Bank may
appoint the customer
or a third party as an
agent to acquire the
service.
Service fee shall be
determined and
agreed upon by the
contracting parties at
the inception of the
Ijarah contract.
The contracting
parties may mutually
agree for the service
fee to be paid by the
customer in the form
of cash or kind; in
advance or in arrears;
in a deferred lump
sum or by
instalments.
FEATURES OF IJARAH OF SERVICES
August 23, 2021 ©2019 Your Company. All Rights Reserved
44
PERMISIBILITY OF
SERVICE
PERMISIBILITY OF
SERVICE …CONT’DAGENCY & SERVICE FEE SERVICE FEES
ISLAMIC FINANCE CONTRACTS
The contractingparties may agreefor the service feeto paid in fixedamount; to bedetermined via areference to aspecifiedbenchmark orformula; or to bepaid using acombination ofboth.
The Bank cannotincrease the service feeonce it is fixed andagreed upon.No increase in theservice fee due may bestipulated by the bank incase of delay in paymentby the customer. Theunpaid fee becomes adebt and any penaltypaid by the customerdue to delay in paymentof the service fee shallbe donated to charity
It is permissible for the
Institution to require
the customer to pay
an initial service
amount to ensure the
customer’s
seriousness in hiring
the acquired service.
This amount of
Customer’s payment
shall be adjusted
against the total hire
amount of the
Services instalments.
The customer shall
be bound to utilize
the Services solely
for the purpose for
which it was acquired
and is intended
FEATURES OF IJARAH OF SERVICES…..CONT’D
August 23, 2021 ©2019 Your Company. All Rights Reserved
45
DYNAMIC OF SERVICE
FEE
INCREASE IN SERVICE
FEE
INITIAL SERVICE
AMOUNTUTILIZATION OF SERVICE
ISLAMIC FINANCE CONTRACTS
STEPS OF IJARAH OF SERVICES CONTRACT
August 23, 2021 ©2019 Your Company. All Rights Reserved
46
EARNEST MONEY
The client’s unilateral
promise to hire the service
and the financial
institution’s acceptance of
collateral. The Bank
requests the client to
furnish a security or
earnest money called
Haamish Jiddiah. In case
the client backs out from
hiring the service, the bank
makes up for the actual
loss from it and returns the
remainder to the client.
AGENCY
The agency agreement
between the financial institution
and the client or a third party.
The Bank must also ensure that
the service to be acquired is not
already in the client’s
possession by paying to the
service provider before the
agent/customer acquires the
services. The Bank can equally
acquire the services directly or
establish a third party agency.
ACQUISITION OF THE SERVICE
The acquisition
of the service by
the agent on
behalf of the
financial
institution.
ACTUAL ASSIGNING OF SERVICE
The exchange of an
offer and acceptance
between the client and
the financial institution
to implement the
assigning of the
service.
ISLAMIC FINANCE CONTRACTS
ISLAMIC FINANCE CONTRACTS
Education
Medical services
Property Rent
Airtime
Consultancy/Advisory
Travels including Hajj and Umrah
Any other permissible services
MAJOR AREAS OF FINANCING USING IJARAH SERVICE CONTRACT
ISLAMIC FINANCE CONTRACTS
Physical asset (buy)
Already owned or enjoyed services
Salaries of companies – Except where the Bank gets
direct contact/contract with the employees of such
companies.
Any services that is unlawful or aims towards
unethical.
NOT ALLOWED UNDER IJARAH SERVICES
Identification of the services by customer
Discussion with the bank
Promise to buy/hire the service
Provision of security deposit
Offer Letter
Ijarah Service Agreement
Necessary documentation
Purchase or hiring of the services by the bank
Sale/re-hire of the services to the customer by the bank at a
higher cost.
ISLAMIC FINANCE CONTRACTS
PROCESS FLOW OF IJARAH SERVICE
MUSHARAKAH (ACTIVE PARTNERSHIP)
A MUSHARAKAH IS A PARTNERSHIP THAT IS SET UP BETWEEN TWO OR MORE
PARTIES USUALLY TO CONDUCT BUSINESS OR TRADE. IT IS CREATED BY
INVESTING CAPITAL OR POOLING TOGETHER EXPERTISE OR GOODWILL.
PARTNERS SHARE PROfiT BASED ON OWNERSHIP RATIOS AND TO THE EXTENT
OF THEIR PARTICIPATION IN THE BUSINESS AND SHARE LOSS IN PROPORTION
TO THE CAPITAL THEY INVEST.
PROfiT CANNOT NOT BE FIXED IN ABSOLUTE TERMS SUCH AS A NUMBER OR
PERCENTAGE OF INVESTED CAPITAL OR REVENUE.
ISLAMIC FINANCE CONTRACTS
Musharakah capitalmay be in the formof cash or it may bein kind, for instancecontributing assetsto the business inwhich case it isnecessary to ensurethe assets arevalued at the time ofMusharakahexecution.
Profit may not be
guaranteed or fixed
in absolute terms for
any of the
Musharakah
partners
Profit may not be set
as a percentage of
capital
One partner cannot
guarantee any part
of the profit or
capital of another
partner.
Silent partner’s
profit ratio may not
exceed his
investment ratio.
During the
Musharakah, a
partner may
surrender all or part
of his profit share to
another provided
doing so is not
agreed at the time
of Musharakah
execution.
Profit sharing
mechanism and
profit ratios must be
clearly determined
at Musharakah
inception.
Musharakah may
only announce an
expected return for
the business; actual
returns are declared
only after they are
known.
FEATURES OF MUSHARAKAH
August 23, 2021 ©2019 Your Company. All Rights Reserved
51
MUSHARAKAH
CAPITALMUSHARAKA PROFIT
MUSHARAKAH
PROFITMUSHARAKAH PROFIT
ISLAMIC FINANCE CONTRACTS
PROCESS FLOW OF MUSHARAKAH
August 23, 2021 ©2019 Your Company. All Rights Reserved
52
ISLAMIC FINANCE CONTRACTS
ISLAMIC FINANCE CONTRACTS
Any business that is permissible can be considered.
However emphasis should be on only businesses that
could not be accommodated by either Murabaha,
Ijara etc.
Bring examples…………………..
AREAS OF MUSHARAKAH OPERATIONS
MUDARABAH (SILENT PARTNERSHIP)
A MUDARABAH IS A PARTNERSHIP BETWEEN TWO OR MORE PARTIES USUALLY TO
CONDUCT BUSINESS OR TRADE. TYPICALLY, ONE OF THE PARTIES SUPPLIES THE
CAPITAL FOR THE BUSINESS AND THE OTHER PROVIDES THE INVESTMENT
MANAGEMENT EXPERTISE.
WITH RESPECT TO THE SCOPE OF BUSINESS ACTIVITY, MUDARABAH MAY BE
UNRESTRICTED OR RESTRICTED.
UNRESTRICTED MUDARABAH: THE MUDARIB IS FREE TO INVEST CAPITAL IN ANY
SHARIAH-COMPLIANT PROJECT OF HIS CHOICE.
RESTRICTED MUDARABAH: THE MUDARIB’S INVESTMENT OF CAPITAL IS RESTRICTED
TO SPECIFIC SECTORS AND ACTIVITIES AND/OR GEOGRAPHICAL REGIONS ONLY. HERE
TOO, ALL INVESTMENTS MUST BE SHARIAH-COMPLIANT.
ISLAMIC FINANCE CONTRACTS
Partners capitalmay be in the formof cash or it may bein kind, for instancecontributing assetsto the business inwhich case it isnecessary to ensurethe assets arevalued at the time ofMudarabahexecution
The capital
contribution can be
made by more than
one Rabb al Maal.
The Mudarib can
also contribute
capital provided that
the Rabb al Maal/
Arbaab al Maal
approve
Only the Mudarib
possesses the right
to manage the
business.
The profit sharing
mechanism must be
clearly defined for all
the partners at the
Mudarabah’s inception
or before profit or loss
is generated.
A partner may
voluntarily surrender
all or part of his profit
share to another
partner provided it is
not pre-agreed at
contract execution
The Rabb al
Maal/Arbaab al
Maal bear(s) the
entire loss
based on capital
contribution
ratios. The
Mudarib does
not bear any
loss except that
caused by his
proven
negligence.
FEATURES OF MUDARABAH
August 23, 2021 ©2019 Your Company. All Rights Reserved
55
MUDARABAH CAPITAL MUDARABAH BUSINESS MUDARABAH PROFIT MUDARABAH LOSS
ISLAMIC FINANCE CONTRACTS
PROCESS FLOW OF MUDARABAH
August 23, 2021 ©2019 Your Company. All Rights Reserved
56
ISLAMIC FINANCE CONTRACTS
Rabb-ul-mal
(Investing Partner)
(4) Profit
Investor bears loss(2)
Capital
Mudarabah
Enterprise
Mudarib (Managing
Partner)
(3)
Expertise
(5)
Profit and
Performance Fee
(1)
Profit-Sharing
Agreement
ISLAMIC FINANCE CONTRACTS
Deposit Sourcing:
Savings Account
LOTUS Profit Sharing Account
Mudaraba Term Deposit
Financing:
Not yet operational due to issues of moral harzard.
AREAS OF MUDARABAH OPERATIONS
DIFFERENCES BETWEEN MUSHARAKAH AND MUDARABAH
MUSHARAKAH
All partners have the right to
participate in the business.
All partners must contribute capital.
All partners bear loss pro-rata to their
capital contributions
MUDARABAH
The Mudarib is solely responsible for managing the
business.
The Rabb al Maalprovides the business
capital.
Rabb al-Maal bears any loss to the
business provided it is not due to the
Mudarib’s negligence
ISLAMIC FINANCE CONTRACTS
WAKALAH (AGENCY)
WAKALAH IS A CONTRACT IN WHICH A PERSON (THE PRINCIPAL OR MUWAKKEL)
APPOINTS A REPRESENTATIVE (THE AGENT OR WAKIL) TO UNDERTAKE
TRANSACTIONS ON HIS/HER BEHALF, THAT THE PRINCIPAL DOES NOT HAVE THE
TIME, KNOWLEDGE OR EXPERTISE TO PERFORM THEMSELVES — SIMILAR TO A
POWER OF ATTORNEY AGREEMENT IN CONVENTIONAL LEGAL TERMS.
THE AGENT'S SERVICES MAY INCLUDE SELLING AND BUYING, LEASING, LENDING
AND BORROWING, DEBT ASSIGNMENT, GUARANTEE, GIFTING, LITIGATION AND
MAKING PAYMENTS, AND MAY BE UTILIZED IN NUMEROUS ISLAMIC PRODUCTS
LIKE MUSHARAKAH, MUDARABAH, MURABAHA, SALAM AND IJARAH.
WAKALAH ARE OF TWO TYPES VIZ:
WAKALAH WITHOUT FEE: WHERE THE BANK APPOINT ITS CUSTOMER AS AN
AGENT TO UNDERTAKE TRANSACTIONS ON HIS/HER BEHALF SUCH AS IN
MURABAHAH FINANCE, ISTISNA, ETC.
WAKALAH WITH FEE: WHERE CUSTOMERS APPOINT THE BANK TO INVEST THEIR
FUND ON AGENCY CONTRACT FOR A FIXED FEE, AND AT TIMES WITH A PROMISE
TO SHARE FROM THE PROFIT, IF THE RETURNS ON INVESTMENT EXCEEDS A
PARTICULAR BENCHMARK.
ISLAMIC FINANCE CONTRACTS
KAFALAH (GUARANTEE)
THIS IS A CONTRACT IN WHICH A THIRD PARTY ACCEPTS AN EXISTING
OBLIGATION AND BECOMES RESPONSIBLE FOR FULFILLING SOMEONE’S
LIABILITY. IT IS A PLEDGE GIVEN TO THE CREDITOR THAT A DEBTOR WILL REPAY
HIS DEBT.
IN CONVENTIONAL FINANCE, THIS SITUATION IS CALLED SURETY OR
GUARANTEE.
HOWEVER, IN ISLAMIC FINANCE, KAFALAH IS A GRATUITOUS CONTRACT. THIS
MEANS THAT THE SERVICE RENDERED BY THE GUARANTOR IS DONE FREELY
WITHOUT ANY REWARD OR PAYMENT. HOWEVER, IT IS POSSIBLE THAT A
GUARANTOR MAY RECOVER ACTUAL COST INCURRED FOR HIS SERVICE.
ISLAMIC FINANCE CONTRACTS
QARD HASSAN (BENEVOLENT LOAN)
QARD IS A LOAN EXTENDED ON A GOODWILL BASIS, WITH THE DEBTOR ONLY REQUIRED
TO REPAY THE AMOUNT BORROWED. IT IS THAT LOAN WHICH A PERSON GIVES TO
ANOTHER AS A HELP, CHARITY OR ADVANCE FOR A CERTAIN TIME (CHARITABLE OR NON-
COMMUTATIVE CONTRACTS).
THE REPAYMENT OF LOAN IS OBLIGATORY.
THE LENDER IS NOT ENTITLED TO DEMAND OR ENJOY ANY KIND OF BENEFITS FROM THE
BORROWER ON ACCOUNT OF THE LOAN. THIS IS BECAUSE THE LENDER HAS NOT
UNDERGONE ANY RISK, SINCE THE BORROWER MUST MAKE REPAYMENT TO THE LENDER
UPON REQUEST.
IMPOSING ANY SPECIFIC BENEFIT ON ACCOUNT OF THE LOAN BECOMES USURY, SAME
APPLIES WHERE THE BORROWER PROMISES THE CREDITOR A GIFT OR BENEFIT ON
ACCOUNT OF THE LOAN.
HOWEVER, THE SHARIAH PERMITS HUSNUL QADA (I.E. GRACIOUS REPAYMENT OF
LOANS/DEBTS) WHERE A DEBTOR REPAYS THE LENDER IN EXCESS OF THE PRINCIPAL OF
ISLAMIC FINANCE CONTRACTS
Non-Delivery of Asset in Murabaha
The Case:
•A murabaha was concluded with the customer and charges were taken by the Bank for 9 months without actually delivering the asset to the customer.
Shari’ah issue:
• Murabaha is a sale and no sale if the seller did not deliver the asset to the buyer.
Causes:
• Allowing customer to handle everything alone.
• Customer was not made to understand the importance of Shari’ahcompliance or even to know how murabaha works
MURABAHA TRANSACTION
CASE STUDIES OF SHARIAH NON-COMPLIANCE
• Depending on agency by allowing customer to do everything.
• Vendor does not own asset thereby invalidating the initial contract between him and the bank.
• Asset was not delivered to the customer which means no valid sale has taken place between the Bank and customer.
• Customer paid the bank principal and profit which is considered interest because no asset is involved.
Decision taken
• Transaction is invalid and all income earned for the 9 months should be reversed to charity.
MURABAHA …….Cont’d
CASE STUDIES OF SHARIAH NON-COMPLIANCE
MURABAHA …….Cont’d
Learning Points:
• Ensure you verify every invoice to ascertain its genuineness and availability of the asset with the vendor.
• Verify all vehicle finance to ensure that vehicles are actually purchased.
• Ensure that delivery is taken by the Bank and if done by agent, this should be clearly confirmed.
• Avoid disbursement when vendor does not have asset available.
• Ensure our customers understand how our products work and the dynamics involved especially in murabaha.
CASE STUDIES OF SHARIAH NON-COMPLIANCE
IJARAH TRANSACTION
Charging Rent Without Availability of Usufruct
The Case:
• A customer complained through the ACE that asset was not delivered to her while she was charged rent for several months. She complained that the contract she signed on Ijarah wa Iqtina stated that rent will be taken by the Bank on availability of the usufruct of the asset.
Shari’ah issue:
• Rent cannot be charged in all Ijarah contracts without the customer having access to the usufruct.
Causes:
• Financing asset under construction without taking care of the rent issue.
• Improper structuring of the facility and poor communication with customer.
• Lack of compliance with Shariah in the initial contract between the Bank and the supplier/owner as no date of delivery is specified.
CASE STUDIES OF SHARIAH NON-COMPLIANCE
• Not complying with conditions put in place in the agreement by the Bank itself.
• Lack of use of Istisna for transactions in which the asset are not ready and requires construction.Decision taken IAJA
• All income charged to the customer in the name of rent which was in excess of N2 million is not valid and should be refunded to the customer.
Learning Points
• Ijarah wa Iqtina is made for ready made asset and should be treated as such and where it must be combined with Istisna, rent should not be charged until asset is ready and delivered.
• The Bank must honor whatever conditions are contained in contracts signed by the Bank with their customers.
• Rent must only be charged when the asset and its usufruct is ready and handed over to the customer.
• Staff handling transactions must understand what is contained in contracts given to customers and their Shari’ah as well as legal implications.
• Offer letters presented by customers for financing must contain dates of delivery to enable the bank monitor the stages of construction.
CASE STUDIES OF SHARIAH NON-COMPLIANCE
IJARAH ……….Cont’d
The Case:
A customer of the Bank was availed a facility under Murabaha financing for the purchase of KOROPE BUS for which payment was made to the vendor directly (as required by Shari’ah). The vendor sent back the money to the customer’s account with a narration ‘Your Money’ referring to the money paid by the bank as customer’s money.
Shari’ah issue:
•There was fund diversion between customer and vendor.
•Where it came to the knowledge of the bank, it has become non-permissible transaction.
Issue of fund diversion in Murabaha sale contract
CASE STUDIES OF SHARIAH NON-COMPLIANCE
• Money meant for asset purchase collected back by customer and subsequently repaid to the bank in excess is regarded as interest which is prohibited in Shari’ah.
Causes
• Inability of the bank/representatives to confirm genuineness of transaction before contract execution.
• Poor monitoring after disbursement by the account officer.
• Absence of/or poor policy in place in relation to asset delivery.
• Lack of awareness of Islamic banking products and services and its modalities by some account officers/relationship managers.
• Disregard for Shari’ah issues in observing transaction sequence by processing officers.
• Ulterior motive of the customer
Cont’d………
CASE STUDIES OF SHARIAH NON-COMPLIANCE
• Lack of proper awareness on the side of customers on how Islamic finance contracts are packaged and executed.
Decisions taken:
• Invalidation of the transaction.
• Income reversed to charity account.
• Customer was made to apologise to the bank for connivance.
Learning Points:
• The branch did not ensure that asset is delivered.
• The Murabaha sequence as advised by ACE was not strictly followed.
• Delivery by the Bank was not taken seriously by the staff.
• Relying on customer to do everything.
Cont’d………
CASE STUDIES OF SHARIAH NON-COMPLIANCE
ISSUE OF FUND DIVERSION IN IJARA SERVICE CONTRACT
The Case:
• A travel agent that was to provide the service paid by the Bank in favour of a customer, transferred all the money (less 100,000.00) to the accounts of the customer in Bank A and Bank B. The customer utilized same money via POS, ATM withdrawals and fund transfer to third party. All these happened within the day of disbursement.
Shari’ah Issue:
• Fund meant for the purchase of the service and sale of same to the customer was routed back to the service beneficiary.
• Cash transferred back to the beneficiary, implies that the beneficiary indirectly collected cash upon which excess is charged for repayment with addition and this eventually becomes interest which is not permissible in shariah.
• There was connivance by the parties (customer and vendor) to go against the principles of shariah upon which the bank was established.
CASE STUDIES OF SHARIAH NON-COMPLIANCE
Cont’d…………
Causes:
• Lack of strict adherence to the ACE approved sequence of Ijarah service.
• Ignorance of customers on modalities of Islamic finance contract especially unique contract like Ijarah service.
• Reliance on the customer as agent to handle the transaction.
• Delivery of the service which is a requirement of Shariah was not emphasized by the branch.
CASE STUDIES OF SHARIAH NON-COMPLIANCE
Cont’d…………
Decision taken:
• The transaction was declared invalid.
• Income earned was transferred to charity.
• Customer was blacklisted and advised to repay the facility immediately.
• The service provider was also blacklisted for breach of trust and connivance.
Learning Points:
• Fund diversion is against the principles of Sharia.
• Like in Murabaha, it is a requirement in Ijarah service for the Bank to own and deliver service to the customer.
• The Bank should monitor closely every stage of transaction in Ijarah service as no physical asset is involved in most cases.
• Staff should take the advice of Shariah seriously.
CASE STUDIES OF SHARIAH NON-COMPLIANCE